Journal entries for hedging transactions. On January 1, when the interest rate is 9 percent per year, Floating Issue Company issued at par \(\$ 10\) million of variable-rate bonds, with semiannual interest payments based on the market interest rate at the beginning of each six-month period. It simultaneously entered into an interest-rate swap with Counterparty Bank: it agrees to pay the bank at the end of each six months the difference between 9 percent interest and any variable interest rate below 9 percent as of the beginning of the six-month period; the bank agrees to pay Floating for any difference between the variable rate and 9 percent when the variable rate exceeds 9 percent at the beginning of the six-month period. If the market rate is \(r\) at the beginning of the six-month period, then Floating will pay the bank at the end of the sixmonth period an amount equal to \(1 / 2 \times(.09-r) \times \$ 10,000,000\). The market interest rate is 9 percent at the time of issue. Interest rates decrease to 6 percent by the end of the first six-month period. Floating will pay interest at the rate of 9 percent for the first six-month period and at the rate of 6 percent for the second six-month period. The market value of the variable-rate bonds does not change. The market value of the interest-rate swap decreases to \(\$ 3.8\) million by the end of the first sixmonth period. By the end of the year, interest rates rise to 7 percent. The market value of the variable-rate bonds continues not to change, but the market value of the interest-rate swap increases to \(\$ 2.7\) million.

a. Record journal entries for the following dates: January 1, at the time of bond issue; June 30, at the time of the first debt-service payments; December 31, at the time of the second debt-service payments.

b. Is this a fair-value hedge or a cash-flow hedge? Can you tell how effectively the hedge has fulfilled its purpose?